Bulls and Bears Locked in an All-Out War

Bulls and bears have been locked in an impressive battle for the past several weeks, as we can see on the weekly chart below:

Four straight weeks of indecision from the market makes it unwise to become overconfident about what's coming next here (since we are not, after all, smarter than the market).  So for this update, I've prepared both bull and bear charts, along with some guide levels to help determine which side is claiming victory going forward. 

I'm also going to go out on a technical limb with my preferred projections, which I'll cover in a moment.  As always, I could very well be wrong -- so I want to note that the blue trend line on the chart above is clearly important to the market, and sustained trade above that trend line would favor the more immediately bullish options.

With that warning out of the way, let's cover the options and the levels which will help sort one from the next.  The main chart which is influencing my preferred outlook is the Philadelphia Bank Index (BKX).  I'm convinced that the recent decline in BKX was a five-wave impulse, and that means it was either the first wave of corrective move, or the last wave of one.  I realize that sounds confusing, but that info will actually help us sort things out going forward.  There are two counts shown here, and there's been no change since 2/28 -- in fact, while red wave a exceeded my expectations minimally, wave b found support exactly where projected on the chart in last Thursday's update.

I'm never certain if the preferred counts are correct; this is always a game of probabilities -- but we have to start somewhere and build a thesis from there, so I'm presently sticking with the idea that the BKX preferred count is correct.  That leads me to look at the S&P 500 (SPX) in a way that allows the two markets to reconcile.  The preferred SPX count, shown in blue below, projects an expanded flat.  The expanded flat does require another leg up, and the preliminary target is the 1540 zone.  Sustained trade above 1541 would suggest the more bullish count (shown later). 

There's an interesting struggle pending if bulls reclaim 1525:  the struggle between the short-term pattern and the intermediate-term resistance trend line (refer back to the first chart, upper blue line). The preferred count shown below gives the intermediate resistance level the benefit of the doubt, and suggests the market needs a bit more coiling and confusion before it can build up the potential energy to clear these levels. 

There is also a more immediately bearish alternate count shown in green; unless/until the bulls push through here, the three-time rejection in the 1525-1530 zone can't be ignored.

SPX, INDU, BKX: Can We Draw a Conclusion from Three Fractured Markets?

Long-time readers will recall that I've written about fourth waves as my arch-nemesis, and the current market hasn't disappointed me in that sense.  The market has been whipsaw city for the past few sessions, and this is typical behavior for a fourth wave -- which is one of the reasons I despise them, and generally simply avoid trading them except for very low-risk entries that I'm often quick to exit. 

While it's tempting to look at yesterday's rally as the "all clear" for the bulls to proceed into a fifth wave rally, I would simply caution that price is still within the fourth wave trading range, and fourth waves are almost never as straightforward as they appear at first (or second... or third...) glance.  Further, we are presently seeing some fracturing across markets. 

Yesterday, I called attention to the Philadelphia Bank Index (BKX), which appears to have formed an impulsive five-wave decline.  This is a tricky one, though, because the preceding move was a mess, and so the impulsive decline could conceivably be the c-wave of an expanded flat correction ("alt: (4)" label).  However, I presently do not believe that's the case; I'm more inclined to view that decline as a first wave down ("(1)/A" label), and am not yet convinced the correction there is over. 

That leads me to a more complex count in the S&P 500 (SPX), which I'll share momentarily.  Further, note how much BKX is lagging SPX in price, and that's often not a good sign for SPX.  As long as this fracture between markets continues, it's more likely that BKX will ultimately win that battle and drag SPX lower, as opposed to vice-versa.

The bottom line here is that I'm inclined to believe that BKX will see lower prices before it sees new highs, and that suggests SPX will be struggling uphill for the time being.  We'll watch this carefully going forward for signals which either validate the rally in BKX as corrective, or which suggest that rally is becoming impulsive in nature.

The impulsive decline in BKX leads me to believe that one of two outcomes awaits SPX.  The first option is that the current correction will become more complex in nature (blue 4 below).  The second option is that SPX will make a new high for wave 5, but that it won't be significant (red "alt: 5").  I would like to caveat that I'm front-running the market with this conjecture, and the intermediate trend is still clearly up -- so play along at your own risk. 

Another market which has now gone its own way is the Dow Jones Industrial Average (INDU).  INDU made a new high yesterday, and SPX often follows suit.  So we have BKX, SPX, and INDU each doing their own thing.  SPX presently seems to fall right in the middle of the two, so hence my conjecture that a retest or marginal new high followed by a decent reversal is in the cards.  This proposal actually matches the INDU count quite well, as the present rally leg does appear to be the final fifth wave in INDU's series.

INDU's rally is presently corrective (an ABC), and has not yet formed five waves at micro degree. 

SPX Update: Will the Market Break this Pattern?

Some nights I study so many charts that I have no idea how I get the update finished -- and this is one of those nights (I know for most people, the sun is up already -- but for me, since I live in Hawai'i, the market opens at 4:30 a.m.).  I've been studying chart after chart, because there's something bothering me about this market, but I can't quite put my finger on it.  Sometimes when I look at enough charts, I can figure out what my gut is trying to tell me -- and sometimes it's nothing.  Maybe my feeling of nagging discomfort is just normal bull market "wall of worry" stuff.  I ran out of time tonight, and couldn't quite pin it down, but may have come close with a ratio I watch.

Since this is a currency-driven rally in the form of the QE printing press, I often try to view things through a dollar-lens, so to speak.  The chart below is a ratio of the S&P 500 (SPX) to US Dollar.  This is a bit inconclusive at present, but the chart explains the reason for caution:  what's bothering me right now is that every rally prior to this (in the QE era, anyway) has begun a deep correction right where we'd normally expect a fourth wave decline and a fifth wave rally.  Maybe this rally will break that pattern -- but given the precedent, it seems unwise to simply assume it will.

The Philadelphia Bank Index (BKX) is also warning that a larger turn may be in the works.

The NYSE Composite (NYA) shows that bulls probably need to hold the black dashed trend line, or risk bigger problems:

The preferred count for the SPX still has the active downside target of 1470-1473.  I went over the one-minute SPX chart in detail tonight, and it is possible that the market has completed an ABC fourth wave correction in its entirety (hence the alt: 4), but I presently view that as the underdog.  And, as I just noted, I'm having trouble simply assuming we'll even have a fifth wave up.  The annotation from yesterday still sums up my approach right now.

Finally, a short-term chart of the Dow Jones Industrial Average (INDU) which staged a pretty solid snap-back yesterday.  The chart is simply for aid in identifying potential support and resistance areas throughout today's trading session.

In conclusion, if it weren't for the market's behavior over the past few years, I would normally be reasonably confident in the idea of a fourth wave decline now underway, and a fifth wave rally still to come.  But given the three-wave nature of most rallies since 2009, I am continuing in my cautious stance until I see more signs of an "all clear" from the market.  Trade safe.

Reprinted by permission; Copyright 2013 Minyanville Media, Inc.

SPX and INDU: Ambiguity Remains the Order of the Day

In yesterday's outlook, I outlined the fact that I felt the S&P 500 (SPX) was quite ambiguous, and as a result, choose to focus on the Dow Jones Industrials (INDU) as a waypoint -- hopefully one which would help in unlocking the wave count in SPX.  I expected INDU needed to make a new high, which it did -- however, SPX did not follow suit and stalled right at the key 1525 resistance level.

We are now within potentially dangerous territory for traders.  I can tell you from experience that this is where many traders do great damage to their accounts, as they attempt to anticipate the market's next move based solely on prior expectations.  My advice in this market would be to "live in the moment," as the saying goes, and trade only what you see.  We booked a nice profit for January/February, and it's now critically important not to give that profit back trying to call the next turn.  Please avoid the temptation to think that any system is so flawless that it can see several months and "three turns" down the road.  As I wrote about at length yesterday, the climate has shifted, and this is now a market that we need to take one day at a time. 

The bearish engulfing bar yesterday has to be respected over the near-term.

INDU fell short of the upside target, but did fulfil the minimum expectation of a new high and reversal.  This topping pattern should be respected unless INDU can whipsaw solidly back into the trading range.

SPX also presents a topping pattern.  Both indices haven't yet moved far enough below the pattern to preclude bullish whipsaws, but "what we see" here presently appears bearish. (continued, next page)

Market Wants to Take Things "One Day at a Time"

It goes without saying that nobody wants to get caught looking up when it's time to look down, and vice-versa.  This is especially challenging in a market such as this one, where the long-term picture is, quite frankly, ambiguous at best.  While the market's bullish intentions seemed fairly clear to me over the past couple months, the market has now reached a zone where (for the moment, anyway) we have to unravel the outlook on a day-by-day basis. 

I analyze charts first and fundamentals second -- but usually we have some type of fundamental backdrop from which to draw, which creates a reasonble overarching framework for the technical analysis.  Either things are getting worse or they're getting better; either the economy is growing or it's dying (as any good entrepreneur will tell you, these are the only two real options in business: there is no status quo), and we can use that information as a waypoint for what then seems reasonable and likely within the charts. 

However, this is an unusually challenging market environment because equity rallies have been driven, in large part, by the world's central banks.  On a fundamental level, the long-term outlook for this market seems to hinge almost solely on the outcome of inflation vs. deflation.  If the central banks can maintain an inflationary environment, then equities will continue to rise; if they can't, or they choose not to, then equities will fall. 

And now we must add a technical ambiguity to the fundamental ambiguity, created by the very-long-term resistance zones which are being reached in most major indices, including the S&P 500 (SPX) and the Dow Jones Industrial Average (INDU).  The mid-to-high 1500's have held SPX in check for more than a decade, and have rejected two prior rallies -- and both rejections then led to protracted bear markets.  Accordingly, we have to view this area as strong resistance, and realize that any long-term decline which begins in this zone will, in retrospect, appear to have been blatantly obvious. 

I don't think we're quite "there" yet, and my preferred outlook does still expect higher prices.  From a long-term perspective, I'm still slightly favoring the bulls as long as the Fed keeps the printing presses running at full throttle -- nevertheless, my confidence in the long-term is marginal at best, for the reasons outlined above, and I remain on alert for the bears to show up in force at any time.

Last update's preferred count expected the market was closing in on completing a fourth wave correction, and after the SPX broke below 1510, it found support directly in the middle of the highlighted support zone on my 10-minute chart (1492-1503).

Let's take a look at INDU first, because I feel the near-term pattern is a bit less ambiguous than SPX.  INDU appears to have completed a complex fourth wave flat correction, and if this is correct, it should be ready to move higher and into the next target zone of 14,200 +/- (not coincidentally, this lines up well with the all time historic high).  Unless the bears used up all their firepower on the recent drop, it's quite possible there will be a fair number of sell orders awaiting in this zone, and the wave counts are suggesting INDU is moving into a fifth wave rally (the final wave before a larger correction), so there's every reason for caution heading forward.

We'll start with the long-term chart.  Note the target zone from January lines up with the all-time high, which lines up well with the upper boundary of the red channel -- and thus bulls should be quite cautious as this zone is approached (assuming we get there, of course).  It goes without saying that any sustained breakout through this zone would be bullish and suggest that my wave counts are too conservative, but normally I would expect to see a correction begin after this next thrust higher.

On the shorter time-frames, both my preferred count and first alternate are viewing the recent low at 13,834 as the bottom of a fourth wave, though there is some question in my mind as to which degree that fourth wave is.  Thus, both the preferred and alternate counts are near-term bullish, but suggest a correction is looming after the next thrust up.  This remains a market where we have to unravel the intermediate term from the short-term, and the long-term still remains veiled -- but it pays to be aware that my bearish long-term count presently suggests the very real possibility that the market is approaching a long-term top.  I would currently give that count better than 35% odds.

The red trend line should provide early warning that something more immediately bearish may be afoot, while trade beneath the 13,834 low (prior to a new high) would invalidate both fourth wave counts.  I'm going a little bit out on a limb here and not labeling an alternate count that shows the high as being in, but that is, of course, always a possibility.

I started this article with INDU charts because I'm building the SPX count from the INDU pattern.  SPX is much more ambiguous and difficult to interpret, and reminds me of the scene in the movie Airplane when Lloyd Bridges hands a radar printout to his partner and asks: 

"Johnny, what can you make out of this?"
And Johnny replies: "This?  Well, I can make a hat, or a broach, or a pterodactyl..."

Assuming my interpretation of INDU has any merit, then SPX has also likely completed its fourth wave correction and should be headed higher.  The same warnings and caveats apply, and it is expected that the market is entering a fifth wave rally, which will then be followed by a more significant correction, or worse.  Assuming 1530 is reclaimed (invalidating the alternate count), then the preliminary target for wave 5 is 1548-1565 -- I'll attempt to narrow this down further as the wave develops.  I would currently place the odds that wave 5 is underway at roughly 60%. (continued, next page)

Is the Fed Serious, or Are They Simply Trying to Scare Speculators?

Yesterday saw the release of the latest Fed minutes, and they revealed considerable dissention among committee members as to how long QE should continue, and whether or not it should be scaled back.  There was even a proposal about whether to vary the pace of asset purchases on a meeting-by-meeting basis (talk about volatility!).  The minutes seem to show a divided Fed who suddenly appears to be questioning its own policies, and the committee is presently less unified than we've seen over the prior few years.  A review of the current program has been set for March -- so let's all Simonize our watches and mark our calendars for March 20, at which time Ben Bernanke will hold a press conference in the aftermath of the Fed's two-day meeting. 

The big question in my mind is whether this is "real" dissention, or simply the flip side of a coin we've seen from this Fed before.  For the past several years, when we've been in-between QE programs, the public-relations strategy was clearly to "keep hope alive" for new QE programs.  Of course we don't need to talk hope anymore, because now we have QE-Infinity, which (in its current form, anyway) is effectively a huge green light for bulls, screaming that the market is endlessly back-stopped.  The message has been: "Buy risk assets at any price, and we'll make sure there's always liquidity flowing in to cover them."

As a result, the present problem faced by the Fed is no longer "how do we keep hope alive?"  Instead, the problem they face is how to gain control of the monster they've created, and how to put the brakes on rampant speculation.  We've travelled 180 degrees, from "Let's talk up QE and keep the market hopeful," to: "Let's talk down QE and keep the market grounded."     

Which brings me back to my original question:  Is this simply part of their PR strategy?  Or is the Fed genuinely having second thoughts?  Obviously, I have no way of knowing, but I think it's a valid consideration.  If they are having second thoughts, then that's a critical piece of information, and the market realizes that: hence the sell-off yesterday.  If this is simply a PR strategy, then this is a temporary scare. 

This has largely been a Fed-driven rally since 2009.  Without the Fed's "greater fool" purchasing power, it's unlikely risk assets would continue on their present upward course.  This conclusion requires little in the way of speculation:  every time a QE program has ended, the market has sold off (plus an angel gets its wings).  Of course, we do need to remember that QE hasn't actually ended yet, and may not end anytime soon.  All we have right now is the "threat" of QE maybe possibly sort of ending -- and again, I wonder if this isn't simply the Fed playing the game of "verbal monetary policy tightening" the way they used to play the same game in reverse, when Bernanke would run around making statements such as, "My finger is on the QE button!" 

Nevertheless, perception is often reality for the market, and with the release of yesterday's minutes, we do have a watershed event that clearly shifted at least the near-term sentiment.  In fact, yesterday evening, a headline on Market Watch read:  Dow Suffers Second Biggest Drop of 2013.  To quote one of my favorite lines from the old TV series M.A.S.H.:  "That's roughly comparable to being the finest ballerina in all of Galveston."

While I make light of the temptation to jump all over yesterday's dip as the Eighth Sign of the Apocalypse, there are actually a couple issues we'll cover from a technical perspective which tell us bulls do need to stay on high alert here.   

The first revolves around that fact that the most recent breakout failed to reach the short-term upside targets (SPX fell about 4 points short).  The near-term pattern whipsawed, which indicates that sellers came in earlier than they would normally be expected to -- and this is sometimes the type of behavior we see near larger turning points.  The chart below shows the whipsaw of the green triangle pattern, and the failure of multiple up-sloping trend lines, along with the penetration into the support shelf in the 1514 zone.  If support fails at 1509-1510 the odds are good we're headed to retest the area highlighted by the blue box. 

The odds presently favor a bounce in the next session or two (which could be viewed as a selling opportunity by the nimble), followed by new lows. 



I've largely ignored the bear counts since 2013 began, because up until now, I saw no reason to be bearish at all.  It's rare that I have enough confidence in my preferred read of the market to essentially publish only one count, but it makes it much easier for people to follow along with the outlook when I'm saying "the two main options I see here are higher or higher." 

Now, however, responsibility and prudence dictate that it's time to give the bears a bit more airtime.  As of yesterday, we cannot ignore the fact that we do have the potential of a completed ABC rally off the November lows.  While I still prefer the more bullish outlook, which suggests a fourth wave correction and fifth wave rally still to come, there is another fact I can't ignore:  every rally leg since October 2011 counts better as a corrective rally.  And that means if this current rally follows that same pattern, it could be entirely complete.

So: here we are with the market having now completed three clear advancing waves (shown below as the black ABC).  That means we have to at least consider, and remain aware of, the possiblity that this is all she wrote for the intermediate term, and the market could embark on a much deeper correction than I'm currently anticipating. The daily chart (not shown) shows a bearish reversal bar, and down volume vs. up volume was strong yesterday -- and those warnings must be respected, since both typically argue for lower prices.

Let's also take a look at the Philadelphia Bank Index (BKX), which I've been using as a leading indicator for a long time now.  BKX actually warned of this turn in advance, when it made a new low last Friday.  I noted the warning (before it happened) in Friday's update, but was uncertain how to interpret it immediately. 

The BKX chart also presents another potential issue for bulls: this leg can now be counted as a complete five wave rally, which would suggest a deep correction is forthcoming.  Quite frankly, that last bit of wave structure is an absolute mess and nearly impossible to interpret cleanly, which leaves enough wiggle room for the black alternate count.  Nevertheless, this may be an early warning sign and needs to be watched carefully going forward. (continued, next page)

Understanding Technical Analysis Using the Current Market

In the pre-market update of February 14, I anticipated that 1514 would become an important short-term support level, and so far the market's bounced twice from that level.  I'm going to use this opportunity to unveil a bit of the "magic" behind technical analysis, and discuss some of the logic behind it, and a few of the reasons why anticipating future price action based on technical analysis works more often than it doesn't. 

The 10-minute SPX chart now sports a pretty decent triangle consolidation, which has been formed with two rejections at the 1524 level, and two bounces off the 1514 level (see chart below).  1514 has been tested several times now, and support becomes more important each time it's tested.  In a moment I'll discuss why.  I'll also discuss why we can further anticipate that this is now quite likely to have turned into a market where additional buyers will show up at higher prices, while additional sellers will arrive at lower prices.

Everybody knows the rule that support tends to become resistance and vice-versa, but I don't know if everyone has thought through why this happens.  Investors who think that technical analysis is some kind of "voodoo" clearly haven't thought much about it, but it's all very interesting to me from a psychological standpoint. 

Let's say the market is moving down to test support.  As it hits support, bulls are buying, which usually causes the market to bounce, especially on the first test of support, and sometimes on the second test or beyond.  But, obviously, it doesn't bounce every time (if it did, of course, then trading would be ridiculously easy).  On the times that support fails, we end up with many of the bulls who bought the level earlier now trapped at a loss -- particularly the ones who bought on that last leg down, just before support broke.  When support fails, the breaks are usually fast, and trap more than a few people, since most traders won't put their stops that close (unless they're scalping; nobody wants to get whipsawed out by a few points).

Shortly after the break, the majority of the time the market rallies back up to the zone that broke -- so if you bought it earlier, you have a decision to make: do you take the chance to exit very close to break-even, or do you stay long and strong with your original stop?  If enough of the trapped bulls do decide to take that exit, then that prior support zone becomes resistance, as the market gets hit with a wall of sell orders on the rally.  If the bulls are of high conviction and don't sell, or if the market has simply exhausted its sellers (sometimes "too many" stops are run when the break happens, and you end up with traders chasing back into their original positions), then you get a whipsaw.

Let's study a real-life example, using the 10-minute S&P 500 (SPX) chart.  When we study this chart a little more closely, we can see that sellers came in at 1514 in a pretty big way on two occasions during the first week of February (on the way up).  Unfortunately for some sellers, due to the gap up on February 8, it's a fair bet that any sellers who came late to the party got trapped short.  We can then see the back-test of 1514 on February 11, and further reason that some of those trapped sellers surely elected to cover their positions -- but it's unlikely that all of them did.  SPX has only moved up about 10 points since then, so it's also a reasonable bet that a fair number of swing-trader bears are still holding onto their shorts.

Looking to the upside, 1525 has rejected the advance twice, and thus now becomes an obvious stop-loss level for shorts.  Typically, most traders will leave a bit of cushion beyond the obvious level, so we should assume 1525 plus a few points.  The chart also shows us that ever since February 8, the market has been in a battle between buyers and sellers -- the pinball back and forth action tells us that bulls and bears are pretty equally balanced in this zone.  And that then tells us another piece of information about 1525: if the market does more than take a quick peek above that level, additional buyers should show up in the form of short covering (and possibly also in the form of bulls who are hoping to buy in lower, but will feel the urge to chase a break higher).  The reverse is true of 1514 on the downside: 1514 (minus a few points) has become an obvious stop-loss level, so we can make a reasonable assumption that additional sellers will show up below that level.  This is why the triangle breakout or breakdown can be projected to run at least 10 points. 

So, sustained trade beneath 1514 is very likely to lead to a test of the next support shelf, in the 1495-1500 zone, where buyers are likely to show up again.  Sustained trade above 1525 is likely to lead to 1535 (+/-), where many short-term traders will take profits.   

Technical analysis really isn't a bunch of voodoo, it's simply based on trader psychology.

We've discussed and charted the triangle above.  In classic technical analysis, triangles typically show up as continuation patterns to the prior trend, which in this case was up; more rarely, triangles are reversal patterns.  In Elliott Wave analysis, triangles always show up as continuation patterns, but typically show up as the penultimate (second to last) wave in a waveform.  There are two challenges here for Elliott Wave: the first challenge is determing whether or not this is a true Elliott triangle, and thus "destined" to resolve higher.  The second challenge is which wave it would actually complete if it is a triangle.  Neither question has a clear-cut answer right now, so this becomes a bit of a "confirmation" market.  Trade below 1514 would rule out an Elliott Wave triangle, while trade above 1525 would largely confirm it. (continued, next page)